Yesterday Canadian Foreign Minister Freeland resumed meetings in Washington with USTR Lighthizer for a third week of NAFTA talks since the Trump Administration announced a bilateral deal with Mexico August 27. There were no breakthroughs.

September 12-13 Freeland is in Canada for the Liberal Caucus Retreat, where she will brief Prime Minister Trudeau. Negotiators continue bilateral talks this week, pushing for progress on pending areas to be able to release text by the end of September.

McLarty’s assessment of three possible NAFTA scenarios is below.

OVERVIEW:

Canadian Foreign Minister Freeland resumed talks with USTRLighthizer in Washington yesterday to tackle unresolved areas of the NAFTA negotiation as the three countries push to reach agreed text by the end of the month. The Canadian Government has acknowledged the distance between the United States and Canada on matters including dispute settlement (Chapter 19), intellectual property, culture, and government procurement, as well as dairy supply management. There are open questions concerning the sunset clause. Freeland is discussing the status of the talks with Prime Minister Trudeau at the Liberal Caucus Retreat today and tomorrow.

Trudeau and Freeland have consistently espoused obtaining a win-win-win, stressing they “won’t sign an agreement unless it is good for Canada and good for Canadians.” Dairy supply management remains a sticking point for the vote-rich provinces of Ontario and Quebec, with provincial elections in Quebec October 1. This complicates the political calculus for Trudeau and his Liberal Party.

The Trump Administration expects Canada will provide dairy concessions equivalent to or better than in the Trans-Pacific Partnership (TPP). Speculation centers around the trade-offs under consideration as Trudeau and Freeland meet. Dairy for Chapter 19? Government procurement for culture? Will currency provisions be included? How enforceable will dispute settlement be?

Meanwhile, the current Mexican Government has intensified its narrative highlighting the success of having reached an early preliminary agreement with the United States in the face of US threats to withdraw from the trilateral deal. Mexico is also pressing the importance of reaching an agreement with Canada and is staying in close touch with Canadian and US negotiators.

The White House continues to be optimistic about reaching a trilateral deal. Press Secretary Sanders said Monday, “We continue to have ongoing conversations with the Canadians and are still hopeful we’ll come to an agreement with them.” Tuesday, President Trump stated that Canada wants to “make a deal very much. Me? If we make it, that’s good; and if we don’t make it, that’s OK too. Canada wants to make a deal.”

Section 232 Tariffs in Question

Freeland has insisted that aluminum and steel tariffs be addressed outside of the NAFTA talks, restating last week, “The 232 tariffs and the NAFTA negotiations are entirely separate. It is not part of a trade negotiation, it ought not to be.” Part of this insistence relates to the already-applied aluminum and steel tariffs, part relates to concerns over the pending auto 232, particularly given that Mexico reportedly agreed to a tariff rate quota (TRQ) on autos not complying with the NAFTA rules of origin to mitigate the potential damage of any national security determination.

Meanwhile, in an interview this week, a key advisor from the Mexican private sector, Moisés Kalach, said that Section 232 tariffs should be removed before Mexico signs a new trade agreement with the United States and implied that Mexico may agree to quotas on steel and aluminum, following the Korean model. Economy Secretary Guajardo has also reinforced that Mexico would like to resolve aluminum/steel with the United States prior to signing a reworked NAFTA.

SCENARIOS: The following NAFTA scenarios remain possible, with varying probability:

Scenario 1: Canada reaches agreement, with text

The best-case scenario foresees Canada agreeing to a deal like Mexico’s, but with TPP dairy concessions likely included, as well as a resolution of pending sunset, dispute settlement, intellectual property, culture, and procurement concerns. The initial deal may be a similar “agreement in principle,” with pressure to arrive at text quickly. While there would be serious shortcomings in any such deal from a private sector perspective (as was the case with Mexico), agreeing to text by October 1[1] allows the countries to sign a trilateral agreement before Mexican President Peña Nieto leaves office on December 1. While not entirely legitimate under TPA, it is possible the parties will consider releasing text October 1 with the inclusion of some limited brackets (reflecting pending items).

A complicating factor is the Quebec provincial election October 1. French-speaking Quebec is the heart of many Canadian culture concerns and represents around 50% of the Canadian dairy industry. Any concessions in dairy (probable) or culture (improbable) would directly hit Quebec, meaning the Canadian Government will not be keen to announce the details/text of a deal prior to the Quebecois election.

Importantly, releasing text on October 1 allows Trump to assert that he “fixed NAFTA” before the US midterm elections on November 6. The White House hopes that announcement of a new NAFTA – likely with a new name – will show farmers and ranchers suffering under 232/301 tariff retaliation that Trump has a plan to protect them and to provide market access.

Given that the TPA timeline (attached) pushes a vote on NAFTA 2.0 until the next (probably more Democratic) congress in 2019, we expect Trump will be tempted to condense the timeframe for congressional review, perhaps by consolidating the time allocated for the required ITC study. This could allow for a congressional vote late this year – potentially even encroaching upon Congress’ holiday break. If Congress balks at bending (breaking?) TPA rules, threat of presidential withdrawal from the agreement is possible, which could result in a legal challenge. However, by early December the midterms will be in the rearview mirror, so a legislative check on executive power might be considered.

232 Focus: How the 232s would be addressed is unclear. We suspect that Canada will continue to press to keep NAFTA talks distinct from 232 and will not easily agree to voluntary export restraints (VER), as VERs are illegal under the World Trade Organization. However, the Canadians may be pushed to consider TRQs for autos not meeting the NAFTA rules of origin.

Scenario 2: Mexico/Canada separated

Despite Mexico leaping ahead to agree to a (ostensibly temporary) bilateral with the United States on August 27, both Mexico and Canada have asserted a preference for NAFTA to remain trilateral. While harmful to integrated North American supply chains, particularly autos, this scenario should not be discounted if an impasse with Canada occurs.

The US private sector and Congress have spoken out since August 27 to reinforce that NAFTA must remain trilateral. However, congresspersons have resisted directly tying a bilateral deal to violation of the TPA letter launching the talks in May 2017. If bilateral text is advanced October 1 – even with a promise of bringing Canada along later – we expect the outcry in support of a trilateral NAFTA to intensify. The result should (hopefully) be a messy reconstitution of NAFTA 2.0 as a trilateral deal. Presidential withdrawal remains a viable threat to try to bring either Canada or the US Congress along.

Scenario 3: Negotiations drag out, withdrawal likely

If negotiations with Canada stall and pressure for a trilateral deal is insurmountable, it is possible that the “deadline” of September 30/October 1 for text would come and go, with talks continuing. The date is tied to the Mexican desire to have current President Peña Nieto sign the deal. Trump wants good trade news for the midterms. Continuing talks would not be the United States’ or Mexico’s preference, but delay could be employed to attempt to circumvent a train wreck.

However, any slippage in the presentation of text would likely lead to a Trump withdrawal. This would open the six-month waiting period mandated by NAFTA article 2205 to allow for a mutually beneficial resolution of the talks. If the USG withdraws, however, the US relationship with Mexico and Canada would deteriorate further and Congress would likely get involved, especially after the midterms.